RBI Proposes Guidelines for Model Risk Management

On 5th August 2024, the Reserve Bank of India (RBI) proposed new principles for managing model risks in credit for banks and other regulated entities to enhance prudence and robustness in credit management.

The RBI's draft circular introduces regulatory principles aimed at addressing model risks associated with credit management, including credit appraisal, borrower scoring, and risk management.
The draft emphasizes that models used by regulated entities are inherently uncertain due to assumptions that may not always reflect real-world scenarios, exposing entities to model risk.
To mitigate these risks, RBI proposes that regulated entities establish a Board-approved policy covering the entire model life cycle, including governance, oversight, and documentation.
The policy should address aspects such as model development, selection, independent validation, change control, and the role of internal audit functions.
Models may be developed internally or sourced from external suppliers, with the policy needing to define objectives, problem statements, and solutions clearly.
The draft outlines that each model must be validated before deployment and undergo periodic reviews at least annually to ensure accuracy and relevance.